W-2 vs 1099: What Each Costs the Employer
The full cost of an employee against a contractor, and the classification test that decides
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A W-2 employee costs the employer the wage plus roughly 10 to 20 percent more in payroll taxes, unemployment insurance, workers' compensation, and benefits; a 1099 contractor costs the fee and nothing else. The difference is real — but the employer does not choose. Classification is decided by the control and independence in the relationship, not the label.
On this page
What does each cost?
| Cost item | W-2 employee | 1099 contractor |
|---|---|---|
| Pay | Wages, plus overtime for non-exempt hours over 40 | The invoiced fee |
| Employer Social Security and Medicare | 7.65 percent of wages (6.2 percent up to the US$184,500 wage base for 2026 + 1.45 percent) | None — the contractor pays self-employment tax (15.3 percent on 92.35 percent of net earnings) on their own |
| Federal unemployment (FUTA) | 0.6 percent of the first US$7,000 (US$42 per employee) | None |
| State unemployment (SUI) | The state rate on wages up to the state wage base — 1 to 6 percent for most small employers | None |
| Workers' compensation | Premium by class code — under 1 percent of payroll for office work, 5 to 30 percent for trades | None (the contractor carries their own or the employer is exposed) |
| Benefits | Health insurance (employer shared-responsibility rules at 50 or more full-time employees, counting equivalents), retirement plan contributions, paid leave — where offered or mandated | None |
| Administration | Payroll processing, W-2s, withholding deposits, Form 941/940, state reports | A W-9 on file and a 1099-NEC in January |
| Total loading | Typically 10 to 20 percent above wages before benefits; 25 to 40 percent with health and retirement benefits | Zero |
A US$50,000 employee in a trade might cost the employer US$58,000 to US$62,000 before benefits; the same person as a contractor costs US$50,000. That gap is the temptation, and the reason the industry defaults described throughout this site's trade guides exist.
Who decides which one the worker is?
The facts, under the tests — not the employer, not the worker, and not the contract they signed. The federal common-law test weighs behavioral control (does the business direct how, when, and where the work is done?), financial control (does the worker have an investment, unreimbursed expenses, other customers, and a chance of profit or loss?), and the relationship (permanency, benefits, whether the work is a key part of the business). Many states apply the stricter ABC test for unemployment and workers' compensation: the worker is an employee unless (A) free from control, (B) doing work outside the usual course of the business, and (C) engaged in an independently established trade — and prong B alone makes a painter working for a painting company an employee. A worker on the company's schedule, using its equipment, doing its core work, with no other customers, is an employee under every test; a genuine independent business with its own tools, customers, pricing, and the right to decline is a contractor (the classification guide).
What does misclassification cost?
If the IRS or a state reclassifies contractors as employees: the employer's share of Social Security and Medicare for the open years, plus — under section 3509, unless the misclassification was intentional — 1.5 percent of wages for the income tax that should have been withheld and 20 percent of the employee's share of Social Security and Medicare (3 and 40 percent if the required 1099s were not filed); federal and state unemployment taxes; workers' compensation premiums (and the uninsured injury claim that often triggered the audit); overtime under wage-and-hour law for hourly workers; penalties and interest; and, where a retirement plan excluded the workers, plan coverage failures. The trigger is usually one worker filing an unemployment claim or getting hurt. The Voluntary Classification Settlement Program lets an employer that comes forward reclassify prospectively and pay 10 percent of one year's employment tax liability (the most recent year, computed at the section 3509 reduced rates) with no interest or penalties and no employment tax audit of those workers for prior years — applying on Form 8952 at least 120 days before treating them as employees, and only if 1099s were filed for them for the previous three years; the state agencies have their own programs or none.
When is a 1099 the right answer?
When the person is running their own business and you are one of their customers: a plumber you call to fix the office bathroom, a marketing agency, a lawyer, a freelance designer with a portfolio of clients, a licensed subcontractor with their own crew and insurance who takes a defined portion of a job at a negotiated price. The documentation: a W-9 before the first payment, a written scope-based agreement, their certificate of insurance where relevant, and a 1099-NEC by January 31 for anyone paid US$2,000 or more in the year (US$600 for payments before 2026). When the person works only for you, on your schedule, with your equipment, doing what your business does — the 1099 is not the right answer at any price.
Worked example
A cleaning company considers two ways to staff a new commercial contract worth US$180,000 a year in labor. As W-2 employees (five cleaners at US$36,000): wages US$180,000; employer FICA US$13,770; FUTA US$210; SUI at 3 percent on a US$12,000 wage base US$1,800; workers' compensation at US$4.50 per US$100 US$8,100; payroll service US$2,400 — total US$206,280, about 14.6 percent above wages, before any benefits. As "1099 contractors": US$180,000. The US$26,000 difference is what the company would be avoiding — and the cleaners work the company's schedule in its uniforms with its supplies on its accounts, so they are employees under the federal test and under prong B in any ABC state. The company prices the contract at the W-2 cost. Its competitor bids US$20,000 lower using 1099s, wins the contract, and eighteen months later — after one cleaner's unemployment claim — owes three years of employer FICA, SUI, workers' comp premiums, and overtime for the cleaners who worked 50-hour weeks, on every contract it holds.
Frequently asked questions
How much more does a W-2 employee cost than a 1099?
Typically 10 to 20 percent above wages for payroll taxes, unemployment, and workers' compensation, and 25 to 40 percent with health and retirement benefits — versus nothing beyond the fee for a genuine contractor.
Can I choose which to issue?
No. Classification is determined by the control and independence in the relationship under the federal common-law test and, in many states, the ABC test. The contract's label does not decide it.
What are the penalties for misclassification?
Back employer payroll taxes plus a portion of the unwithheld employee share, unemployment taxes, workers' compensation premiums, overtime liability, penalties, interest, and potential retirement plan failures — usually triggered by a single unemployment or injury claim.
What is the ABC test?
A state test for unemployment and workers' compensation (and in some states all purposes) under which a worker is an employee unless free from control, doing work outside the business's usual course, and engaged in an independently established trade. Prong B alone captures most "contractors" doing the business's core work.
Official sources
The IRS states: “Generally, you must withhold and deposit income taxes, Social Security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of Social Security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.” — Internal Revenue Service, Independent contractor (self-employed) or employee?, https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
The IRS describes employment taxes as “the various types of employment taxes you need to deposit and report as an employer, such as federal income tax, Social Security and Medicare taxes and federal unemployment tax.” — Internal Revenue Service, Employment taxes, https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles worker classification reviews under the federal and ABC tests, fully loaded labor cost modeling, Voluntary Classification Settlement Program applications, and payroll transition with repricing. See pricing or book a call.
Cross-border taxes, handled in one place
U.S. and Canadian filings prepared together by our U.S. and Canadian Tax Desks.
Book a free fit call